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Overview

The Fall and Rise of Freedom of Contract

Declared dead some twenty-five years ago, the idea of freedom of contract has enjoyed a remarkable intellectual revival. In The Fall and Rise of Freedom of Contract leading scholars in the fields of contract law and law-and-economics analyze the new interest in bargaining freedom. The 1970s was a decade of regulatory triumphalism in North America, marked by a surge in consumer, securities, and environmental regulation. Legal scholars predicted the “death of contract” and its replacement by regulation and reliance-based theories of liability. Instead, we have witnessed the reemergence of free bargaining norms. This revival can be attributed to the rise of law-and-economics, which laid bare the intellectual failure of anticontractarian theories. Scholars in this school note that consumers are not as helpless as they have been made out to be, and that intrusive legal rules meant ostensibly to help them often leave them worse off. Contract law principles have also been very robust in areas far afield from traditional contract law, and the essays in this volume consider how free bargaining rights might reasonably be extended in tort, property, land-use planning, bankruptcy, and divorce and family law. This book will be of particular interest to legal scholars and specialists in contract law. Economics and public policy planners will also be challenged by its novel arguments.

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The Fall and Rise of Freedom of Contract

Duke University Press

Contracts Small and Contract Large: Contract Law through the Lens of Laissez-Faire

RICHARD A. EPSTEIN

I A Fallen Theory!

Laissez-faire capitalism, along with its associated doctrine of freedom of contract, had many stalwart defenders during the nineteenth century. But it has received a rocky reception from many legal and philosophical commentators in the twentieth century. Freedom of contract has often been pronounced "dead on arrival" as an organizing principle for complex contemporary societies. That principle has been said to be insensitive to differences in wealth, status, position, and power that make the exercise of contractual choice a myth for the weak and dispossessed. Within the legal literature, it has been attacked as ignoring the large concentrations of wealth that distort market processes and that trample down the rights of consumers and workers. Modern writers often rejoice in pointing out the intellectual narrowness and class bias of the leading judicial defenders of the principle, of whom Baron Bramwell was surely one.

This sustained attack on laissez-faire political theory has taken place on two levels. The most obvious level addresses grand themes of industrial capitalism and political discontent. These challenges to laissez-faire found their most vivid expression in several contexts: the role of assumption of risk in torts cases, the role of contract and combination in labor cases, antitrust cases, and the requirements of constitutional rates of return for public utilities and other regulated industries. But a second level of concern has also exerted a surprising influence, especially in legal circles. Here freedom of contract has been criticized not only for its social consequences but also, doctrinally and internally, for its unsatisfactory and confused conceptual foundations. Four of the most influential legal critiques of laissez-faire theories have bored at the system from within instead of assaulting it from without. I speak here of Friedrich Kessler's early critique of "Contracts of Adhesion"; Grant Gilmore's highly influential set of lectures, The Death of Contract-, Lawrence Friedman's Contract Law in America-, and Patrick Atiyah's massive study of contract theory, The Rise and Fall of Freedom of Contract.

In these writings the emphasis shifts from contract large to contracts small. Although these authors advert to the major social themes that surround the debate over laissez-faire, they focus on contract doctrines, such as the rules relating to offer and acceptance or consideration, which at first blush are the stuff of lawyer's law, and not the stuff of political controversy and intellectual unrest. They find that the nineteenth-century synthesis of contract law contains errors, confusions, and equivocations that undercut its intellectual vitality. In one sense, these writers have picked odd doctrinal targets for their work, but the influence of their writing calls for a more sustained examination of their position.

This essay therefore has two central objectives. The first of these is to show that the disputes found in classical contract law, and indeed today, operate for the most part at the fringes of any functioning legal system. No system has to be perfect to survive, and the perceived defects of the nineteenth-century legal regime can be fixed without any major changes to its overall structure. This essay's second objective dovetails with the first. It is to establish the internal coherence of the classical system in order to explain why it does withstand the doctrinal and political attacks launched against it.

This essay seeks to discharge these missions by using both a top-down and a bottom-up approach. The bottom-up approach is the worm's-eye view of contracts law that examines such issues as offer and acceptance, consideration, and conditions. The plural "contracts" is used to stress the diversity of doctrinal and technical issues that are incorporated into this overall mosaic. The top-down approach, contract large, uses the singular. It examines the social and intellectual linkages between contract law, writ large, and laissez-faire. The specific doctrines of contract law, which form the core of standard treatises and casebooks, do not bear any simple relationship to the principles of laissez-faire. Much of contract law is compatible with extensive systems of social regulation, both foolish and wise. Accordingly, the efforts of modern writers hostile to laissez-faire—Kessler, Gilmore, Friedman, and Atiyah—falsely posit an intimate connection between the formal doctrines of contract, derogated under the name of formalism, and the political philosophy of laissez-faire. But they cannot bring down laissez-faire by pointing out the perceived inadequacies and rigidities of the nineteenth-century doctrines of offer and acceptance, or consideration. Nor do the twentieth-century doctrinal developments in these areas presage the inevitable rejection of laissez-faire. Indeed, some developments, such as the explicit articulation of the principle of promissory estoppel, are more consistent with freedom of contract than with its rejection.

The received wisdom on this relationship is often otherwise. Friedrich Kessler's influential critique of the contract of adhesion dwelled at great length on the perceived mischief the rules of offer and acceptance generated in insurance contracts. Kessler deplored the outcome when individual insureds were denied coverage because their policies had not been approved by the home office. Yet he never once asked about the centrality of this issue to the overall scheme of insurance regulation or addressed the principled defenses of the earlier rules. Similarly, Grant Gilmore thought that the survival of the larger principle of laissez-faire stood or fell with the nineteenth-century contractual synthesis of offer, acceptance, and consideration. Lawrence Friedman found a still tighter connection between the two sets of principles.

Basically, then, the "pure" law of contract is an area of what we can call abstract relationships. Pure contract doctrine is blind to details of subject matter and person. It does not ask who buys and who sells, and what is bought and sold. In the law of contract it does not matter whether the subject of the contract is a goat, a horse, a carload of lumber, a stock certificate, or a shoe. As soon as it matters—e.g., if the sale is of heroin, or of votes for governor, or of an "E" Bond, or labor for twenty-five cents an hour—we are in one sense no longer talking about pure contract. In the law of contract, it does not matter if either party is a woman, a man, an Armenian-American, a corporation, the government, or a church. Again, as soon as it does matter—if one party is a minor, or if the transaction is one in which a small auto company sells out to General Motors, or if a seller of legal services happens to be a corporation instead of a partnership or individual—we are no longer talking pure contract. When the relationship of parties to land is involved, this is land law or property law, but not contract. In contract cases land is treated as a commodity on the market, the same as every other commodity, and the rules are supposed to be the same as the rules for horses and cows. If a court says that an insurance contract is "just another contract," or that contracts between the state of Wisconsin and a citizen follow the same rules as any other contracts, the judges are making the same kind of point, are asserting the same abstraction. Contract law is abstraction—what is left in the law relating to agreements when all particularities of person and subject-matter are removed.

The abstraction is not what people think of when they criticize the law as being too abstract, implying that the law is hyper-technical or unrealistic. (Though often it is.) The abstraction of classical contract law is not unrealistic; it is a deliberate renunciation of the particular, a deliberate relinquishment of the temptation to restrict untrammeled individual autonomy or the completely free market in the name of social policy. The law of contract, therefore, is roughly coextensive with the free market.

Friedman's obvious foil was Christopher Columbus Langdell, the originator of the Socratic method and the author of the first casebook on the law of contract, for which he prepared a companion volume, his well-known A Summary of the Law of Contracts. Langdell is a tempting target for any writer, but even so it is dangerous to overstate the connection between Langdell's legal formalism and laissez-faire, or to assume that Langdell's view of the law of contract dominated the judicial writing of the time.

The judges who pondered grand theory also had to make peace with the routine tasks of contractual interpretation, and on these issues they well understood that no market could ever be sustained by the pure theory of contract law standing alone. Contract law must supply default terms for key elements of common transactions both to reduce the costs of forming contracts in the first place and to eliminate uncertainty in contract disputes after the fact. Choosing default terms that lend business efficacy to transactions takes more than abstract principles that transcend commercial categories. It requires good situation sense as well, which the best nineteenth-century judges surely possessed. Ironically, it was Gilmore who devoted far too much energy in The Death of Contract to the sterile dispute over whether the development of general contract principles preceded or followed the emergence of law for particular types of contracts, such as sales, partnerships, leases, and mortgages. In so doing, he missed the obviously correct answer, which is that the two sets of rules developed side by side with reference to each other. Every system of contract law needs both, and this parallelism long antedated the nineteenth-century rise of laissez-faire and continues happily after its demise.

It is therefore critical to unpack the larger relationship between contract doctrine and laissez-faire. In order to do so, it is necessary to distinguish clearly among three interrelated concepts. The narrowest idea is security of exchange: whenever there is a bargain the party who performs first must be secure in the knowledge that it can enforce the agreement against the other side. The grandest conception is freedom of contract, which includes, in addition to the security of exchange, the right to choose one's contracting partners and to trade with them on whatever terms and conditions one sees fit. Midway between them is the doctrine of the sanctity of contract. Under this doctrine, the parties may not have perfect freedom to form whatever contract they choose, but once a contract is made, then one side is not free as a matter of course to vary its terms at will, even if he is prepared to compensate the other side for his losses. The sanctity of contract is analogous to the absolute rights of private property in a world devoid of the power of eminent domain. More specifically, sanctity of contract rejects the principle of efficient breach, and for that reason it exerts a powerful hold on classical contract theorists and ordinary traders, both of whom who resist the facile substitution of cash for performance.

Believers in the freedom of contract are committed to both the sanctity of contract and the security of exchange. But the progression does not operate in reverse. It is possible to defend security of exchange and reject both the sanctity and freedom of contract. Or to defend both the security of exchange and the sanctity of contract and still accept limitations on contractual choice. The law may limit an individual's right to choose his trading partners and still provide remedies for the contracts so made. Nineteenth-century English law imposed restrictions against wages paid in kind, and the twentieth-century law requires the payment of some minimum wages, thereby rejecting freedom of contract but accepting security of exchange. The use of specific performance remedies accepts the sanctity of contract but is consistent with the rejection of freedom of contract, when for example land is inalienable by public decree.

Most importantly, most of the law of contract is not about the principle of freedom of contract. The rules of contract formation, interpretation, discharge, and enforcement consonant with a system of laissez-faire apply with undiminished force to the truncated system of contracts that survive scrutiny in the modern regulatory state. The benefits from security of exchange survive in a legal regime that pays less than total homage to freedom of contract. Indeed, it is hard to think of any philosophical or economic reason to abandon security of exchange as a principle of human interaction.

In order to develop these themes, this essay is organized as follows. Section i deals with the general theory of laissez-faire in relationship to the principle of freedom of contract. Section 3 uses this framework to examine the law, first of offer and acceptance, and then of consideration. Section 4 takes a closer look at the principle of the sanctity of contract in its relationship to doctrines of necessity and impossibility, unilateral contract modification, and deliberate breach. Section 5 concludes with a brief public policy defense of freedom of contract, as understood by its nineteenth-century defenders.

II Laissez-Faire through the Eyes of Foe and Friend

Laissez-faire is a general political philosophy that in its popular sense stresses that government should keep its hands off the economy. While that crude formulation evokes the correct mood, laissez-faire does not deny government any place at all in the running of the economy. Quite the opposite, laissez-faire, at least as viewed by its proponents, conceives a role for government in the creation and stabilization of property rights and in the enforcement of voluntary exchanges between adult parties. The belief in freedom of contract does not banish tort law from the legal system: the law of trespass, nuisance, and defamation, insofar as they protect strangers, form a key, regulatory element of the basic system. Laissez-faire is not anarchy. Like other normative theories, it makes explicit substantive judgments about which kinds of regulation work in the common interest and which do not.

The philosophical foundations of laissez-faire rest on an uneasy admixture of natural law and social contract theory. In contrast, its practical side stresses the bad consequences to civil society that flow from ambitious government regimes of taxation and regulation that violate its precepts. The youthful Herbert Spencer, for example, commingled ideas of natural rights, social contract, and social consequences within the confines of a single essay. This intermingling of rights-based, contracts-based, and consequence-based arguments does not reveal a weakness in the philosophical foundations of Spencer's system; indeed most eighteenth-and nineteenth-century writers thought that these three approaches worked in tandem and not in opposition. While Spencer was quite categorical in his delineation of government functions, the common law, to use the felicitous phrase of Aaron Director, softened that position to provide that government actions that went beyond these limited tasks should be evaluated under a presumption of error.

In its heyday, laissez-faire hardly preserved the status quo or glorified the position of the privileged. Rather, it reflected and nurtured strong reformist impulses. Its historical targets were mercantilism and the welter of special privileges and franchises that operated with government favor and support. In their place, laissez-faire displayed a marked affinity for open competition as the engine of social progress, a view that went hand in hand with the principle of freedom of contract.

Freedom of contract has been attacked, of course, for the restrictive assumptions on which it is said to rest. In particular, Patrick Atiyah noted that the system assumed that "the parties dealt with each other 'at arm's length,'" in a regime where neither was bound to offer any information to the other side, and where "the content of the contract, the terms and the price and the subjectmatter, are entirely for the parties to settle." Under freedom of contract, all this is said to make sense because individuals are the best judges of what is in their personal interest.

While this stark portrait of common law principles of bargaining freedom surely contains important elements of the truth, it misses out on several elements of the system. First, the rule on "arm's length transactions" was never universal, nor should it have been. Contracts for insurance, for example, were contracts uberimmae fides, about which Judge Bayley wrote in 1828, "I think that in all cases of insurance, whether on ships, house or lives, the underwriter should be informed of every material circumstance within the knowledge of the assured; and that the proper question is, whether any particular circumstance was in fact material, not whether the party believed it to be so." The duty, as codified by statute, applies with special strictness for marine insurance, where "the assured must disclose to the insurer, before the contract is concluded, every material circumstance which is known to the assured, and the assured is deemed to know every circumstance which, in the ordinary course of business, ought to be known by him. If the assured fails to make such disclosure, the insurer may avoid the contract." Such a rule, whether statutory or contractual, makes good sense given the obvious asymmetry of information with respect to the covered risks. Likewise, many of the default terms at contract contain implied warranties of seaworthiness or merchantability, which again match the commercial intuitions of both the nineteenth century and our own.

Editorial Reviews

“A compendium of original scholarship about the continuing vitality of our legal and political regime based on contract. This is an important book.”—Fred S. McChesney, Northwestern University School of Law

“An interesting and impressive collection of essays that pulls together important research and arguments by an unusually impressive lineup of contributors. This a major piece of work.” —Paul H. Haagen, Duke University School of Law

“One of the most notable trends in recent legal scholarship is the reinvigoration of the contract paradigm, and these original papers by some of the most distinguished North American law-and-economics scholars make a strong case for the virtues of contractarianism across a wide spectrum of legal specialties, including contract law, tort law, family law, bankruptcy, and private international law. The commentaries develop nuanced concepts, such as efficiency-enhancing limitations on contractual freedom. This important, impressive, and timely collection, accessible to a wide audience, should become the standard reference on free bargaining and contractarianism.”—Thomas S. Ulen, University of Illinois College of Law

“These brilliant essays show that the ethic of respect for the uniqueness of individuals can influence and justify a return to bargaining freedom in a surprising variety of legal areas.”—James W. Bowers, Louisiana State University Law Center

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